Introduction to Business Taxation ‘Finance Act 2004’ ppt

Introduction to Business Taxation
‘Finance Act 2004’



Introduction to
Business Taxation
‘Finance Act 2004’
Chris Jones, BA CTA (Fellow) ATT

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CONTENTS
Preface

ix

A: Introduction to the UK Tax System

1

B: Computation of Taxable Trading Profit

7

B1: Trading Income and the Badges of Trade

7

B2: Adjustment of Profit

15

B3: Capital V Revenue

25

B4: Capital Allowances – Definition

33

B5: Capital Allowances – Computation

43

B6: Industrial Buildings Allowances

55

B7: Intangible Fixed Assets

73

B8: Research and Development Expenditure

79

B9: Tax Law and Accounting Practice

87

C: Taxation of Limited Companies

95

C1: Computation of Corporation Tax

95

C2: Associated Companies

105

C3: Short Accounting Periods

115

C4: Long Periods of Account

123

C5: Corporation Tax Self Assessment (CTSA)

133

C6: Payment of Corporation Tax

143

C7: Interest on Late Paid Tax

151

C8: CTSA Penalty Regime

157

C9: Income from Property

163

C10: Loan Relationships

169

C11: Relief for Trading Losses

177

C12: Relief for Other Losses

187

C13: Corporate Capital Gains

193

C14: Rollover Relief

203

C15: Shares and Securities: Matching Rules

211

C16: Substantial Shareholdings Exemption

277

C17: The Principles of Group Relief

233

C18: Group Capital Gains

247

C19: Close Company Definition

259

vi Content

C20a: Close Company Implications – Part 1

265

C20b: Close Company Implications – Part 2

271

C21: Investment Companies

277

C22: Corporate Venturing Scheme

283

D: Employee Tax Matters

293

D1: Employed or Self Employed?

293

D2: Introduction to Employment Income & Benefits

301

D3: Company Car & Fuel Benefits

315

D4: Living Accommodation – Taxable Benefits

327

D5: Loans to Employees & Use of Assets

335

D6: Miscellaneous Benefits

343

D7: Expenses of Employment

353

D8: Calculating the Income Tax Liability

363

D9: Introduction to PAYE

371

D10: PAYE End of Year Returns

381

D11: Class 1 National Insurance Contributions

389

D12: Class 1A and 1B National Insurance Contributions

399

D13: Termination Payments

409

D14a: Occupational Pensions & Furbs

423

D14b: The New Pension Regime

429

D14c: The Enterprise Investment Scheme

431

E: Value Added Tax

439

E1: Overview of the VAT System

439

E2: Registration

445

E3: Definition of Supplies

453

E4: Liability of the Supply

457

E5: Schedule 8 VATA 1994 – Zero Rating

461

E6: Schedule 9 VATA 1994 – Exemptions

469

E7: Value of the Supply

473

E8: Deemed Supplies and Self-Supplies

485

E9: Time of Supply

497

E10a: Input Tax: When to Recover

505

E10b: Partial Exemption

509

E11: VAT Records and Returns

527

E12: Accounting for VAT

539

E13: Bad Debt Relief

551

E14: Control Visits, Appeals and Assessments

555


Contents vii

E15a: Misdeclaration Penalty

569

E15b: Late Registration Penalty

575

E15c: Default Surcharge

581

E15d: Repeated Misdeclaration Penalty

589

E15e: Other Penalties, Interest and Mitigation

595

E16: Refunds, Repayment Supplement and Interest

607

PREFACE
This book provides all the material you need for the CIMA Professional Development
Certificate in Business Taxation. Within each chapter you will find some examples for
you to try, to test you on the important rules covered in the chapter.
At the end of each chapter, there is a short summary which contains a “pocket digest”
of the rules covered within the chapter. These individual summaries form a
comprehensive overview of the syllabus.
As this manual has been written specifically to cover all areas of the syllabus we are
confident you will find this an invaluable tool leading to success in the examination.



A: INTRODUCTION TO THE UK TAX SYSTEM

In this chapter you will cover the following areas in overview:
- the various taxes levied in the UK;
- the period for which income tax is charged;
- the categorisation of sources of income;
- the sources of income that are exempt from income tax.

All statutory references are to the Income and Corporation Taxes Act (ICTA) 1988 unless stated otherwise.

A1.1

Taxes in the UK
The UK government raises in the region of 230 to 250 billion pounds in taxation
each year.
Income tax is the single largest earner for the government making up 30% of
total revenue. Income tax is charged on salaries from employment, on rental

income from properties let out, on interest from banks and building societies, on
dividends from companies and on the profits of the self employed.
The second largest earner for the government is value added tax (VAT). This
makes up about 23% of the total government revenue and is charged by
businesses to customers on supplies of goods or services in the UK.
National Insurance contributions (NIC) make up 21% of total government
income. National Insurance contributions are generally paid by both employers
and employees on earnings from employment, although NIC is also levied on self
employed persons on the profits of their trade.
Income tax, VAT and NIC are the three most important taxes as far as raising
money is concerned, making up about 75% or so of total government revenue.
A large part of the remainder (16%), is made up of duties, being taxes on
alcohol, petrol and tobacco, as well as certain levies on goods coming into the UK.
Corporation tax makes up about 8% of total government revenue, being the tax
paid by UK companies on their taxable profits.
The remaining slice consists of the “capital taxes” being capital gains tax (CGT),
inheritance tax (IHT), stamp duty (SD) and stamp duty land tax (SDLT). Capital
gains tax is the tax levied when individuals sell assets and make a profit.


2 Introduction to Business Taxation ‘Finance Act 2004’

A1.2

The tax year
Individuals pay income tax by reference to the “tax year”. The UK tax year runs
from 6 April to the following 5 April. For example, the tax year that begins on
6 April 2004 and ends on 5 April 2005 is known as the tax year 2004/05.
The tax rates and tax allowances for the 2004/05 tax year, were set in the
March 2004 Budget. The Budget became a Finance Bill, which in turn became

the Finance Act 2004 in the summer of 2004.
There are two stages in calculating an individual’s tax liability. First we compute
the individual’s taxable income from all sources in the relevant tax year. Having
arrived at taxable income we then apply the 2004/05 tax rates and allowances
to that income, to arrive at the tax liability for the year. This tax will be
collected by the Inland Revenue under the “self-assessment” system. This will be
dealt with in a later chapter.

A1.3

The Schedules
The tax legislation categorises the various sources of income under “Schedules”.
The first Schedule, Schedule A, taxes income from land and buildings in the UK.
Schedule A, therefore, taxes rental income from properties which are let out.

s. 15

Schedule B has been abolished and does not need to be considered any further.
The same is true of Schedule C which has also been abolished.
Schedule D is the largest of the Schedules and covers a variety of sources of
income. Schedule D is then divided into sub schedules called “Cases”, and we will
deal with the six cases of Schedule D further below.
Schedule E used to be a very important schedule, taxing income from
employment such as salaries, bonuses and benefits in kind. Schedule E was
abolished with effect from 6 April 2003 and is now simply called “Income from
earnings and pensions”. The new rules are, however, substantively the same.
The last schedule is Schedule F, which taxes dividends from UK companies.
A1.4

s. 18

s. 20

Schedule D
There are six “Cases” within Schedule D. Schedule D Case I taxes profits from
a trade. For instance, a self employed person in business as a taxi driver,
market trader, builder or plumber, would pay tax under Schedule D Case I.
Schedule D Case II taxes profits from a profession or a vocation. For
example, a self employed professional such as a solicitor or barrister would pay
tax under Schedule D Case II, as would a self employed singer, sportsman or
entertainer.

s. 18


Introduction to the UK Tax System 3

Schedule D Case III taxes interest arising in the UK.
interest from UK banks and UK building societies.

This will include

Schedule D Case IV taxes income from overseas securities, whilst Schedule D
Case V taxes income from overseas possessions. It is important to note that
income could still be taxable in the UK, even if it arises from a source outside
the UK.
As a general principle, individuals who live in the UK, and who were born in the UK
will pay UK income tax on their worldwide income wherever it comes from. For
example, a UK resident individual will pay income tax under Schedule D Case V on
income from rents arising outside the UK or on foreign bank interest, or on

foreign dividends.
Finally, Schedule D Case VI taxes income that is not taxed under any other
case or any other schedule.
A1.5

Exempt income
There are a few sources of income which are specifically exempt from income
tax. Income from National Savings Certificates is exempt from tax, as are any
winnings on Premium Bonds. Any income from betting, gaming or lotteries is
exempt from income tax.

s. 46

Most social security benefits are also exempt from income tax. The notable
exceptions to this are the state pension and any job-seekers allowances. These
are taxable income.

s.660
ITEPA 2003

Any statutory redundancy pay received on the termination of an employment is
also exempt from income tax.

s. 309
ITEPA 2003

Scholarship awards are exempt, as is any income from ISAs (individual savings
accounts).

SI 1998/1870

Example 1
Categorise the following sources of income:
a) Interest from a UK bank
b) Rents on a villa in Spain
c) Wages from a part-time job
d) Child benefit
e) Rents from a cottage in Devon
f) Profits from running market stall


4 Introduction to Business Taxation ‘Finance Act 2004’

Answer 1
a)
b)
c)
d)
e)
f)

Interest from a UK bank
Rents from a villa in Spain
Wages from a part time job
Child benefit
Rents from a cottage in Devon
Profits from running a market stall

Sch DIII
Sch DV

Income from earnings
Exempt
Sch A
Sch DI


Introduction to the UK Tax System 5

SUMMARY - INTRODUCTION TO THE UK TAX SYSTEM

The main taxes in the UK are income tax, VAT, NIC, corporation tax, capital gains tax
and inheritance tax.
Income tax is paid for a tax year which runs from 6 April to 5 April.
Income is categorised into the following Schedules and Cases:
Schedule A
Schedule D Case I
Schedule D Case II
Schedule D Case III
Schedule D Case IV
Schedule D Case V
Schedule D Case VI
Schedule F

Income from UK land and buildings
Profits from a trade
Profits from a profession or vocation
Interest arising in the UK
Income from overseas securities
Income from overseas possessions
Income not taxed elsewhere

Dividends from UK companies

Schedule E has been abolished and is now called “Income from earnings and pensions”.
Some income is exempt from income tax such as:
Income from National Savings Certificates
Premium bonds winnings
Income from Betting and Lotteries
Most social security benefits
Statutory redundancy pay
Income from ISAs



B: Computation of Taxable Trading Profit
B1:TRADING INCOME AND THE BADGES OF TRADE
In this chapter we will look at trading income including:
- the schedule for taxing trading income;
- the definition of a trade;
- the “badges of trade” arising from case law;
- land transactions;
- whether receipts are taxable or not.

Statutory references are to ICTA 1988 unless stated otherwise.

B1.1

Schedule D Cases I and II
Schedule D Case I taxes income from a trade, for example plumbing or
building.

s. 18(1)

Schedule D Case II taxes income from a profession or vocation. A profession
would include accountancy or law. A vocation includes acting, ballet dancing,
theatrical performing, sport etc.
There are no notable differences between the way profits are taxed under
DI or DII, so for the rest of this course, when we talk about Schedule D Case
I, the rules equally apply to Schedule D Case II.
B1.2

The definition of trading
Income tax is charged on “the annual profits or gains arising or accruing to any
person residing in the United Kingdom from any trade, profession or vocation”.
This definition is given in S.18 ICTA 1988.
A trade is defined as ”every manufacture, adventure or concern in the nature
of trade”. This is given by S.832(1) ICTA 1988.
A “trade” is defined in the legislation as a “trade”, which is a circular definition
and does not take us a great deal further. Therefore, the interpretation of what
is meant by the term “trade” has been left largely to the Courts. The Courts
have developed a number of tests to determine whether somebody is trading.
These tests are known as the “badges of trade”.

s. 832


8 Introduction to Business Taxation ‘Finance Act 2004’

B1.3

The Badges of Trade

Profit seeking motive
When a person enters into a transaction, we need to identify whether there is a
profit seeking motive. It is not the existence of a profit that is important, it is
the motive to earn one. However the Inland Revenue will really be interested in
this issue if a profit has actually been earned, because then they have something
to tax.
A taxpayer may argue that they are trading in order to utilise a loss to reduce
their tax bill. The taxpayer must demonstrate the motive rather than the
existence of profit to establish that a trade is being carried on.

Frequency and number of similar transactions
If we do something once, never to be repeated again, it is unlikely that we would
be treated as carrying on a trade. However if we keep doing it, it is more likely
that we are trading. For instance, assume I sold my car which I had owned for
four years. I then bought myself another car and sold that one two years later.
It is unlikely the Revenue would consider that I am trading in cars. If, however,
I bought and sold cars every month, it is more likely that they will seek to tax
the profits under Schedule D Case I.
The most notable case in this area is Pickford v Quirke where a taxpayer
purchased a mill with the object of using it for trading purposes. However it
turned out that the mill was in a much worse state than they had imagined and
the best thing the taxpayer could do was to strip all the items out of it and sell
them piecemeal. He made a considerable profit doing this, so he did it again and
again and again. As a result of the repeated number of transactions, it was
held that the profits were taxable under Schedule D Case I.

Modification of the asset in order to make it more saleable
If we buy something, do nothing to it then sell it, it is unlikely we are trading.
However, if we bought a car, put a new engine in it, resprayed the body and made

it more attractive to buy, it is possible we would be considered to be trading.

Nature of the asset
We cannot pin a trading label onto a single one-off transaction simply because we
cannot justify that the particular asset was purchased for any other purpose
than to resell it. The most notable case in this area is Rutledge v CIR.
In this case, a taxpayer purchased 1 million rolls of toilet paper in one single
transaction. He then sold them on at a profit in another single transaction. This
was held to be trading (an “adventure” in the nature of trade) as there was no
other justifiable reason to purchase such a large quantity of toilet paper - he
could not argue that this was simply overstocking!


Trading Income and the Badges of Trade 9

Connection with an existing trade
Taking an example of a car, let us say that as a tax accountant I sell a car. It is
unlikely that I would be trading in cars because there is no link between selling
cars and being a tax accountant. If however I was a car mechanic who
occasionally sold a car, the Revenue are much more likely to successfully tax the
profits on the sale of cars along with my existing trade as there is a direct link
between repairing cars and selling cars. Other badges of trade would also need
to apply, but such a link is something that the Revenue will look very closely at.

Financing arrangements
If an asset is purchased on a short term loan which the taxpayer is unable to
fund without selling the asset again, then the Inland Revenue can successfully
argue that the asset was purchased specifically with a view to selling it.
This was cited in the case of Wisdom v Chamberlain where the comedian Norman
Wisdom bought a mound of silver bullion on a short term loan. He could not

service the interest payments from his existing money, but as soon as he sold
the bullion and repaid the loan he found he had made a substantial profit. This
profit was taxed under Schedule D Case I.

Length of ownership
If you have owned something for a long time, it is much easier to justify that you
bought it for its enjoyment or for your own private consumption. A profit on sale
would not therefore be treated as a trading profit. If however you have only
owned it for a short period it is much more likely that the Revenue could
successfully argue that it was purchased with the aim of selling it at a profit.

The existence of a sales organisation
In the case of The Cape Brandy Syndicate, a syndicate of chartered accountants
distilled brandy. They distilled far more than they could actually drink
themselves and sold the surplus. The Revenue sought to tax them under
Schedule D Case I. They argued that they were simply selling what they could
not physically drink themselves. However as they had set up a special phone line
and information desk and published brochures and adverts advertising their
brandy, the Revenue successfully argued that they had commenced a trade.


10 Introduction to Business Taxation ‘Finance Act 2004’

Reason for the acquisition/sale
Finally, we will look at how the asset was acquired – ie, whether purchased or
otherwise acquired by gift or inheritance - and what is the reason for the sale
of the asset? By way of an example, consider Maud who inherits a wardrobe full
of fur coats from her late mother. She does not want to wear them, so she puts
an advert in the local paper to sell them. The Inland Revenue spot this advert
and seek to tax Maud under Schedule D Case I for any profits earned. As Maud

inherited the coats it is highly unlikely that a trading label can be pinned to
these transactions. However if Maud had purchased a wardrobe full of fur
coats, advertised them and then sold them at a profit, it is much more likely that
she would be held to be trading. Simply realising an inheritance for cash is not
the commencement of a trade.
In some circumstances, the existence of one single badge is enough to show
trading (as in the case of Rutledge v CIR). However in other cases we need to
look at a combination of the badges of trade. The trigger to get the Revenue
interested in the transaction in the first place is the existence of a profit.
B1.4

Land transactions
The Revenue often look closely at the purchase and sale of land and buildings,
simply due to the size of the profits involved. It is in the area of land
transactions that the most cases involving the badges of trade have been taken
to the Courts.
One of the important questions to ask is whether the taxpayer is “investing in
land” or “dealing in land” – “dealing” is trading. This question which was posed
in the case of Marson v Morton. Here a taxpayer purchased some land with the
intention of holding on to it as an investment for at least two years. In order to
increase the value of the land, the taxpayer applied for planning permission.
Looking at the badges of trade, this will be regarded by the Revenue as a
modification to an asset to make it more saleable.
It was held in this case that because the original intention was the purchase of
an investment, no trade was being carried on. It is not what the taxpayer says
which determines intentions, it is what the surrounding evidence supports.
Documented intentions made the difference.
Another question that we must ask is, is whether our taxpayer is a resident in
the property, or a developer who is refurbishing a property for onward sale.
In the case of Kirkby v Hughes, a builder purchased a run-down house. He

carried out a lot of repair and refurbishment work and sold the house at a
healthy profit. He then purchased a strip of land and built a house on it, again
selling it at a substantial profit. He then purchased a barn and converted it into
a house.


Trading Income and the Badges of Trade 11

The Courts believed that he was trading because they could apply enough of the
badges of trade to him. There clearly was a profit seeking motive, he had
modified the assets he purchased, there was a connection with an existing trade,
and the length of ownership in each case was fairly short. The profits on the
first house were held to be taxable under Schedule D Case I along with all of the
other properties he had bought and sold.
Looking specifically at one of the badges of trade we should also identify a
reason for the purchase and a reason for the sale. In the case of Taylor v
Good, a husband purchased a property to be used as a family home. However on
seeing the house, his wife refused to live in it. As a result he had no option but
to sell the house. Despite it being a one-off transaction, the Revenue felt that
the badges of trade applied because the asset was only owned for a very short
period of time. However, there was clearly another reason for the acquisition
and subsequent sale – there was a genuine intention by the taxpayer to live in
the house rather than simply to make a quick profit. Therefore the transaction
was held not to be a trading transaction.
B1.5

Frequency of transactions
Michael buys unprofitable restaurants, turns the businesses around and sells
them at a profit. He has done this 12 times. The idea came to him when he sold
his first restaurant which he had run as the owner and manager for 10 years.

The question we are asking is whether he is chargeable to tax under Schedule D
Case I, first in respect of the restaurants in general, which he had run for a
short period, but also in respect of the first restaurant which he had run for a
long period.
We must look closely at the badges of trade. Clearly there is a profit seeking
motive which is readily identifiable. The frequency of transactions which
Michael is undertaking points towards a trade. Modifications to the asset
purchased (taking an unprofitable restaurant and turning it around), the length
of ownership (he owns them for a relatively short period of time) and the reason
for the sale (to make money), lead us to draw the conclusion that these
transactions will clearly be trading transactions.
The next question is – do the future transactions taint the first one?
Unfortunately the answer to this question is yes. In the case of Leach v Pogson,
an individual had owned a driving school for a long period of time before he sold
it at a profit. He then purchased, turned around and sold numerous other driving
schools in the future. It was held by the Courts that not only were profits from
sales of the later driving schools charged to tax under Schedule D Case I, but
the original disposal, although originally treated as a capital transaction, will
be turned into a trading transaction because of later events.


12 Introduction to Business Taxation ‘Finance Act 2004’

B1.6

Share Dealing
Muriel thinks she has an infallible system to predict share price movements.
Over a two year period she entered into over 100 transactions buying and selling
shares. She made a profit on some but overall she made a loss, so her system
was not as infallible as she thought! Will she manage to obtain loss relief against

her general income?
In order to set a loss against other income, the loss must be a trading loss – we
will come to losses later in this course. The question is whether Muriel is dealing
or investing.
In the case of Salt v Chamberlain it was held that all share
transactions are capital in their nature unless they are undertaken by a properly
registered share dealer. Therefore if a private individual (not a share dealer)
buys and sells shares many many times, he can never have the badges of trade
pinned on to those transactions. Such profits will be taxable as capital gains
and subject to CGT with all the advantages of indexation and taper relief.

B1.7

Taxable and Non-Taxable Receipts
If receipts are wholly unexpected and unsolicited, they are not taxable. This
is highlighted in the case of Simpson v John Reynolds & Co., in which a taxpayer
received a voluntary payment from an ex-customer when they were asked to
cease to act as their insurance broker. Because the payment was not invoiced,
not expected and was purely an unsolicited gift, it was not held to be part of the
taxable trading income.
In Murray v Goodhews, an ex-gratia payment given to a pub landlord as a result
of the cancellation of his pub tenancy was held not to be taxable. The reason
for this was that the receipt of the compensation had nothing to do with him
buying and selling alcoholic drinks and running a pub – it was as a result of the
termination of the pub tenancy.
However, if amounts are expected then they will be taxable. In the case of
Creed v H & M Levinson Limited, a taxpayer was offered an ex-gratia amount
from an ex-customer and successfully sued for more. As the receipt was clearly
solicited and expected, it was taxable. In the case of McGowan v Brown &
Cousins, an estate agent who received compensation for not being appointed as

letting agent, was taxed on the income as it related specifically to the trade and
was solicited and expected.


Trading Income and the Badges of Trade 13

SUMMARY - TRADING INCOME AND THE BADGES OF TRADE
Trading income is taxed under Schedule D Case I. Income from a profession or vocation
is taxed under Schedule D Case II but the rules are the same.
The statutory definition of a trade includes the word “trade”, so tests known as the
“badges of trade” have developed from case law. These include:
- profit seeking motive
- frequency and number of similar transactions
- modifications to sell an asset
- nature of the asset
- connection with an existing trade
- financing arrangements
- length of ownership
- existence of a sales organisation
- how the asset was acquired and the reason for sale.
Land transactions have featured in many cases and the questions to ask also include:
- is the taxpayer investing or dealing?
- is the taxpayer resident in the property or a developer?
If a series of transactions are treated as trading this will taint the first time such a
transaction was carried out so it can no longer be regarded as a capital transaction.
Wholly unexpected and unsolicited amounts are not taxable, however if amounts are
expected then they will be taxable.
The cases covered in this chapter are also summarised in the Case Law Supplement
provided with this course.